Thursday, July 19, 2012

Law School Graduates And The Discretionary Authority Of The Courts In Applying The Brunner "Undue Hardship" Test

In the Case of Hedlund v. Educational Resources Institute, Inc., 468 B.R. 901 (D.Or. 2012) the court addressed whether debtor was entitled to a partial "undue hardship" discharge of his approximately $85,000 in student loan debt. The bankruptcy court granted the student loan discharge, but the Ninth Circuit reversed the bankruptcy court's decision.

Debtor obtained a bachelors of science degree in business administration from the University of Oregon and a law degree from Willamette University. Debtor financed law school by obtaining federal Stafford student loans totaling $85,245.87. Debtor's father and brother are attorneys in Klamath Falls, Oregon, where debtor resides. After graduating from law school, debtor obtained a position with the District Attorney's office in Klamath Falls. Debtor planned on staying at the District Attorney's office for a couple of years, after which time he would then work at his father's law firm. Debtor, however, was unable to pass the bar exam despite sitting for it twice (once in 1997, and again in 1998), and failing to make it to the exam on exam day the third time (in 1999). As of the time the case was filed, debtor had no plans to retake the exam.

Because debtor was unable to practice law, he filed for and received several extensions of his loan obligation. In 1999, debtor's loans went into repayment status, at which time debtor submitted an application for loan consolidation. Because debtor fell behind on his payments under the loan consolidation, debtor was unable to re-apply for consolidation. Debtor chose not to apply for the William D. Ford Income Contingent Repayment Program because he believed that he did not qualify for it.

In 1999, debtor obtained a job as a juvenile counselor at the Klamath County Juvenile Department. Although debtor worked full-time, he did not make the requisite monthly loan payments. In fact, debtor made only one payment on his debt prior to filing for bankruptcy; in September 1999, debtor advanced $954.72 to the creditor using the proceeds of a $5,000 inheritance. Subsequently, debtor made a one-time payment offer to creditor of $5,000 in exchange for more favorable loan terms and waiver of certain assessed fees; creditor declined his offer.

In 2000, debtor got married, and in 2001, debtor and his wife had their first child. Debtor's wife works at a flower shop one day per week for six hours, earning $8.50 per hour. Debtor's wife has the potential to work more, but instead chooses to stay at home with their child.

After two years of nonpayment, the creditor administratively began to garnished debtor's wages. The following year, a second student loan creditor also began to garnish wages from debtor's bank account. Unable to simultaneously manage both garnishments, debtor filed a petition for relief under Chapter 7 of the bankruptcy Code. At that time, debtor was thirty-three years old, married, with one dependent child; he was healthy, had no physical disabilities, and had no drug or alcohol addictions. His annual income was $40,320.

The court began its analysis by applying the three-part Brunner test. Under Brunner, a debtor must prove that: 1) he cannot maintain, based on current income and expenses, a "minimal" standard of living for himself and his dependents if required to repay the loans; 2) additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the repayment period; and 3) the debtor has made good faith efforts to repay the loans. See United Student Aid Funds, Inc. v. Pena (In re Pena), 155 F.3d 1108, 1111-12 (9th Cir. 1998) (adopting the Brunner test).

On appeal from the bankruptcy court, the 9th Circuit independently reviews findings of fact for clear error, while conclusions of law are reviewed de novo. Schwarzkopf v. Briones (In re Schwarzkopf), 626 F.3d 1032, 1035 (9th Cir.2010). Mixed questions of law and fact, such as the proper application of legal standard in determining whether a student loan is dischargeable, are also reviewed de novo. Educ. Credit Mgmt. Corp. v. DeGroot, 339 B.R. 201, 214-15 (Bankr.D.Or.2006).

A. Minimal Standard of Living

The first prong of the Brunner Test requires the debtor to establish that he could not maintain, based on his current income and expenses, a minimal standard of living if he were required to repay the creditor. More than "simply tight finances" and "temporary financial adversity" must be demonstrated; however, a showing of "utter hopelessness" is not required. Rifino, 245 F.3d at 1088. Determining what constitutes a minimal standard of living for each individual debtor requires a case-by-case assessment. The applicable test is whether it would be unconscionable to require the debtor to take steps to earn more income or reduce his expenses in order to make payments under a given repayment schedule. Carnduff v. U.S. Dep't of Educ. (In re Carnduff), 367 B.R. 120. 127 (9th Cir. BAP 2007).

Analyzing the first element, the bankruptcy court determined that debtor had maximized his income, and that it would be unconscionable to require him to work more than forty hours per week. However, the bankruptcy court determined that it would not be unconscionable to require the debtor's wife to work more days per week, especially given the availability of free child care from the grandparents. The court also found that debtor could reduce his monthly expenses by slightly abating his monthly expenses for recreation, clothing, and child care budgets. After factoring in these adjustments, the court concluded that the debtor's monthly surplus was insufficient to make the requisite monthly loan payments. Consequently, the bankruptcy court found that debtor satisfied the first prong of the Brunner test. The Ninth Circuit could not find that the bankruptcy court committed clear error when applying the first prong of the Brunner test.

B. Additional Circumstances

The second prong of the Brunner test requires the debtor to prove that "additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the repayment period of the student loans." The court must "presume that the debtor's income will increase to a point where he can make payments and maintain a minimal standard of living; however, the debtor may rebut that presumption" by introducing evidence "indicating that his income cannot reasonably be expected to increase and that his inability to make payments will likely persist." Educ. Credit Mgmt. Corp. v. Nys (In re Nys), 446 F.3d 938, 95 (9th Cir.2006). The bankruptcy court found that debtor's lack of admission to the bar, his inability to substantially increase his income over the loan repayment period (because he maximized his income in his position, and the closest promotion was eight years away), the absence of current assets, and likelihood that expenses will increase over time because he wants to have more children, were additional circumstances proving that debtor's current financial position is likely to persist for a significant portion of the repayment period. The Ninth Circuit found that the bankruptcy court did not err in regard to the second prong of the Brunner test.

C. Good Faith

The third prong of the Brunner test requires the debtor to affirmatively demonstrate a good faith effort to repay student loans. To do this, the court analyzed a number of factors, including the debtor's efforts to obtain employment, maximize income, minimize expenses, and to negotiate an alternative repayment plan, as well as his history of voluntary payments.

The court begins its analysis of this prong of the Brunner test by acknowledging the bleak circumstances faced by the majority of today's law school graduates. However, the Court found that the debtor's case is distinguishable. The debtor graduated in 1997, a period of great prosperity and rapid economic growth for the United States. Even though debtor was unable to pass the bar exam, he was able to obtain a relatively high-paying job. Moreover, debtor and his wife chose to be a single-income family, which is a lifestyle that few today can afford, especially when free child care is available. Therefore, the court determined that the debtor's financial circumstances are, in part, a by-product of his life choices rather than market forces.

However, the court noted that a more dispositive factor was that the debtor did not meet his burden of proof in showing an affirmative demonstration of good faith. Debtor not only neglected to maximize his income, minimize his living expenses, and make voluntary payments, but he also failed to take any steps toward renegotiating an alternative repayment plan. The court determined that these factors were not beyond his reasonable control. Consequently, the Ninth Circuit found that the bankruptcy court erred as a matter of law in finding that debtor met the third Brunner Prong.

Because the debtor failed to prove the third prong of the Brunner test, the bankruptcy court's order discharging debtor's student loan debt was reversed, and debtor was required to pay off the full debt in the amount of $ 85,245.87.